INSIGHT: Senator’s Insider Trading Allegations Can Be Proved

One day after receiving a classified briefing on the impending effects of the Covid-19 pandemic, Sen. Richard Burr (R-N.C.) sold at least $628,000 in stock and avoided significant losses when the value of those stocks then plunged as the pandemic spread to the U.S. Some outraged observers have called for him to be punished for violating the STOCK Act, which was intended to prevent members of Congress from engaging in insider trading.

But the STOCK Act does not actually create criminal (or civil) liability for insider trading by members of Congress. Rather, it clarifies that members owe a fiduciary duty to Congress for the purpose of previously existing insider trading prohibitions; and that members are subject to the same insider trading rules as anyone else who owes that kind of duty and is therefore barred as an “insider” from trading on material nonpublic information (MNPI).

Burr has effectively conceded that he directed these trades himself, but did so based on public news reports. Much of the commentary on the difficulty of prosecuting him has focused on the difficulty of proving his trades were based on the briefing, rather than publicly available information. Yet meeting the legal hurdle of proving that he traded on MNPI for the purposes of an action for violating Rule 10b-5, the traditional basis for prosecuting insider trading, should not be difficult.

In 2000, the Securities and Exchange Commission enacted Rule 10b5-1, defining what it means for an insider to trade “on the basis of” material nonpublic information: absent specific affirmative defenses, “a purchase or sale of a security … is ‘on the basis of’ [MNPI] about that security … if the person making the purchase or sale was aware of the [MNPI] when the person made the purchase or sale.” 17 C.F.R. § 240.10b.5-1(b).

Therefore, Burr’s defense that he traded because of what he learned from public news reports, rather than from the classified briefing, is irrelevant—all the government needs to prove is that he traded while he was “aware of” the information he received at the briefing, assuming the briefing constitutes MNPI.

However, a prosecution under Rule 10b-5 might have to overcome at least one other hurdle. It prohibits conduct to “include … the purchase or sale of a security of any issuer, on the basis of [MNPI] about that security or issuer, in breach of a duty or trust or confidence that is owed … to any other person who is the source of the [MNPI]” (emphasis added). 17 C.F.R. § 240.10.b5-1(a). The highlighted phrase leads to interesting questions about whether Burr can be prosecuted for violating this rule, even if he traded while aware of MNPI he learned in his capacity as a Senator.

For example, one of the stocks Burr sold was Wyndham Hotels. If the briefing he received specifically described the expected effects of the pandemic on Wyndham’s earnings, then he committed insider trading in violation of Rule 10b-5.

But what if the briefing didn’t include any information specific to Wyndham Hotels, but only that it was likely Covid-19 would become widespread in the U.S.—would that constitute information “about” Wyndham, the issuer in question? It is certainly information other investors didn’t have and would be relevant to whether to buy or sell stock in Wyndham.

What if the classified briefing didn’t focus on the public health aspects of the pandemic, but on the economic effects generally—for example, that the American economy would contract in 2020 due to Covid-19?

Or, what if the briefing was specific to the hotel sector, with an analysis predicting that the rate of hotel rooms occupied in the U.S. in 2020 would fall 50% from 2019 levels, without any mention of Wyndham in particular? Would that constitute information “about” Wyndham for these purposes?

There is no clear answer to these questions, and good lawyers can craft plausible arguments on either side. So a prosecutor would need to learn the specific contents of the classified briefing, compare it with the stocks he traded, and consider the issue closely.

Second Circuit Affirms Novel Use of Mail Fraud Statute

But Burr shouldn’t take much comfort from this legal defense, because of the word “including” that prefaces the quoted passage of Rule 10b5.1(b)—if a prosecutor or regulator has another theory establishing insider trading liability without relying on Rules 10b-5 and 10b5-1, that theory would not be bound by the language and interpretations of those rules.

In fact, the Second Circuit Court of Appeals’ recent decision in United States v. Blaszczak affirmed federal prosecutors’ novel use of the mail fraud statute and a different securities fraud statute (18 U.S.C. §§ 1341 and 1348) to prosecute insider trading.

And in affirming the use of these statutes to charge insider trading, the Second Circuit also held that when prosecuting cases using these statutes the government did not need to prove some of the elements it has to prove when it prosecutes insider trading the “traditional” way, as a violation of Rule 10b5.

Thus, even if prosecutors and the SEC conclude that the information Burr received during the classified briefing did not constitute information “about” a stock in which he traded, he may still face a prosecution for insider trading under these other laws.

This lack of clarity governing insider trading by members of Congress who trade on sector or economy-wide information, like the law governing insider trading generally, calls out for further clarification by Congress and the SEC.

But in the meantime, all insiders should remember that unless they have specific clearance to do so, they may not trade while in knowing possession of MNPI, even if they do not trade because of that MNPI but for other reasons.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Paul Tuchmann is a partner in the White Collar Defense, Investigations, and Corporate Compliance Group at Wiggin and Dana in New York and New Haven, Conn. He was previously an assistant U.S. attorney in the U.S. Attorney’s Office for the Eastern District of New York, where he served as acting chief and deputy chief of the Public Integrity Section and co-chair of the FIFA Task Force.